Danaher Corporation (NYSE:DHR) Bank of America Securities Health Care Conference May 11, 2022 1:00 PM ET
Company Participants
Rainer Blair – CEO
Conference Call Participants
Derik De Bruin – Bank of America
Mike Ryskin – Bank of America
Derik De Bruin
[Call Starts Abruptly] I’m the Senior Life Sciences and Diagnostic Tools Analyst at Bank of America with my colleague, Mike Ryskin, up here on the stage. Welcome to Bank of America’s 2022 Healthcare Conference live in Las Vegas, which we’re all very happy to be out of our shells. With us today is Danaher, and we have Rainer Blair, Chief Executive Officer of the company. Rainer, thank you for being here.Rainer Blair
My pleasure. Thank you.
Derik De Bruin
Rainer and I first met you when I think it was 2009 when you were just taking over the Life Sciences business, and I think we were reminisce — I think we were introducing each other at ASMS in those days…
Rainer Blair
Yes. Exactly.
Derik De Bruin
And the thrills and chills of mass spectrometry at the time. You want to do any — do you want to make any opening comments or just jump right in?
Rainer Blair
No. Well, first of all, thank you, Derik, Mike, good to see you. And good to see all of you in person here. It’s great to be back at it. So thanks for having us.
Maybe just to start with, look, we’re really excited about a strong start of the year. Most of you know that we printed a 12% core growth here, 8% on the base business, right around 10% EPS growth and $1.7 billion of free cash flow. So we feel really good about the way we’ve started the year, and we feel really good about the way we’re positioned.
Many of you know of our portfolio repositioning. And I think that repositioning, which hopefully we’ll get into in a little more detail here, really plays well in nearly any environment, including the kind of environment that we’re in today. So we feel really good about the fact that we’ve re-rated our portfolio from a growth perspective. We feel very good about the 75% recurring revenue that particularly, not only, but particularly in this kind of environment is very strong. And then, of course, the significantly higher earnings profile that we’ve had over the years.
So with that maybe as an icebreaker, over to you.
Question-and-Answer Session
Q – Derik De Bruin
Yes. So let’s start with some big picture questions that you talked about, the portfolio positioning. Your — the company has changed dramatically since we first met, right? I mean you were still doing gas pumps at the time at the company. And so now a little dental. Business has completely changed. It’s like — what’s the — I mean as people are worried about recession, what do you think is the cyclicality and sort of like the exposure of the business today if things get worse?
Rainer Blair
I mean I think one of the most critical parts of our portfolio transformation has been the way we have repositioned to really attractive end markets that have very, very strong secular growth drivers. And as you think about our portfolio today, 40% of that portfolio is either in biopharma or in molecular diagnostics. Over 80% is in Life Sciences and Diagnostics, and our EAS portfolio, environmental and applied systems, is also a portfolio which is characterized by low capital kind of solutions and high recurring revenues. And once again, our company as a whole has 75% recurring revenues.
And as we saw here, not just in 2009 and 2010, but far better even in — during the pandemic, Danaher performed and grew well even in the worst parts of the pandemic here in the second quarter of 2020, and you saw how we powered through the pandemic here with 25% core growth last year and then kicking off this year with a 12% core as well. So we think that we’re positioned really nicely to avoid sort of the typical business cycle that we’ve seen in the past.
Derik De Bruin
And when you look at the portfolio today, I mean Danaher has historically done a lot of ins and outs and moved things around and spun off businesses. I think we keep getting a lot of questions on EAS and sort of like is that really a good fit with the business, is there an opportunity there. I guess, do you — is there opportunities as sort of like still repositioned portfolio? Are there attractive areas that we get into? So this is the moving the capital deployment question and upfront.
Rainer Blair
Sure. Let’s start off with what we’ve done. I mean, as you look once again at this portfolio repositioning, we acquired Pall, we acquired Cepheid, we acquired Cytiva, we acquired IDT, we acquired Aldevron, we acquired Phenomenex. So this portfolio repositioning is a dramatic redeployment of capital. And at the same time, we spun Fortive and Envista, and that’s the company that you see today. And we really like the business scope that we have today.
So if you think about our 4 platforms and the 3 reporting segments, these are characterized by having operating companies that are leading in their markets. They have typically #1, #2 type of positions. They are typically razor, razor blade business models where we have a high number of touch points with our customers to inform our innovation pipeline. And of course, they have a high degree of recurring revenues that is typically spec-ed in and is directly associated with the kind of equipment that we place. So that’s the kind of business that we like, and EAS is a part of that business as well.
Mike Ryskin
On the topic of M&A, I mean, I think your balance sheet is in a really good way. So you’ve talked about the opportunity, the potential to do more deals. Pretty much as soon as you did Aldevron, you were saying you’re back in the market. Why haven’t we seen more action? Is it — especially given what’s going on in the stock market. And in terms of valuations elsewhere, is it seller expectations need to come now? Is it something about the target profile, sort of why haven’t you seen more activity on the M&A front in general?
Rainer Blair
Well, we continue to be as active as ever. Our funnels are full. We are working them as we always do. And as I’ve said in the past, we really do focus on the market, the asset and the financial viability. And as you alluded to here with the market dynamic that we see and some of the volatility, those have historically been great times for Danaher. We have always taken advantage of those. And there are many examples, if I just remind you of SCIEX as one example, which is a great success and, Derik, where the 2 of us met. And you can expect that Danaher is looking at this very closely. But it is also still early days, right? This turbulence has really started at the beginning of the year. And I think it takes time for the market to reset on valuation expectations here, and we’re in no rush.
Derik De Bruin
So in other words, winter is coming. So let’s talk a little bit about the first quarter call. There was a little bit of confusion on the commentary around the bioprocessing outlook and sort of like what was sort of the expectations of COVID and non-COVID business? Can you just sort of like clarify sort of like what your sort of process? And how much of your portfolio, your COVID exposure for you, you’ve derisked sort of in your outlook?
Rainer Blair
Well, first of all, let’s level set on what the guide is for the bioprocessing business here for the full year of 2022, which is high single, low double-digit growth. And as we talked about, we don’t typically — we’ve included, let’s say, the COVID therapeutic and vaccine revenue in the base business. And so we’ve guided in total for high single digits and low double digits. But what is included in that guide and what is accounted for in that guide is that the COVID vaccine and therapeutic revenue could be down by $500 million to $600 million.
So that’s already included in that high single-digit, double-digit total bioprocessing business. And the way we make that happen is that the far larger parts of the non-COVID therapeutic and vaccine business is growing at mid-teens plus, and that is really what’s driving the overall guide of high single digits, low double digits for 2022.
Mike Ryskin
Just to clarify just briefly on that $500 million to $600 million, is that cancellations? Is that delays with the COVID pieces moving around. Is it truly a derisk where you could still end up doing the full $2 billion? Sort of what’s your — how do you arrive at that number?
Rainer Blair
Yes, we actually do see a number of those things. So sure, we’ve seen some cancellations as customers will no longer pursue a COVID project, but in fact, they take the raw materials that they have acquired, and they apply those to the next project that they’re working on. We see some delays where people say, “Look, my next project’s starting up in 60 days instead of right away.” So we see all of that, but we feel that, that would be accounted for in the $500 million to $600 million that we talked about.
Derik De Bruin
Got it. So let’s talk about bioprocessing from a buyer market perspective. I think the — when you think about where the market was pre-pandemic and then sort of where it is right now, it’s like you’ve seen big revenue increases at a lot of bioprocessing companies, right? The market has clearly expanded. I think we get pushback from investors saying, it’s like, “Oh my God, there’s going to be this hole. There’s going to be a glut of capacity or something like this.”
Could you sort of talk about — you could talk about this — once again, this is something I think we disagree with. But I think from — as analysts, it’s really hard for us to sort of look at the pipelines and say — well, of course, yes, COVID is going to come off. But then there’s like there’s this antibody, this antibody, this antibody, it’s going to sort of like fill in and become a gap. So of course, it’s not going to be it. So give us a sense of how we can get comfort that there’s not going to be the sort of like massive air pocket?
Rainer Blair
So there are a number of dimensions that we have to consider here. The first one I would start with is we have to look at the drug development pipelines. So if you think about the largest biologic therapeutic market, which is monoclonal antibodies, the development pipeline has increased by 50%. This is not a small pipeline. It increased by 50% here over the last 5 years. Cell and gene therapies, the pipeline has increased by an order of magnitude 10x where it was 5 years ago. And you see this manifest in the number of clinical trials that are starting anew. And that builds a great deal of confidence in terms of what you can expect playing through.
The next thing to keep in mind is that monoclonal antibodies have a great characteristic. They work for patients. And increasingly, monoclonal antibodies are becoming the standard of care still with a relatively low penetration rate in developed markets, never mind emerging markets where those kinds of therapeutics are still not accessible to the great majority of the population. So the penetration rate of these highly efficacious but already a relatively large market is low, and we continue to expect monoclonal antibodies to be the largest market and to continue to be adopted, and we see more approvals on the way.
In addition to that, monoclonal antibodies have been around for a while now, and some of those are starting to come off of their IP protection, and you’re starting to see biosimilars, and you see those popping up not just in the developed markets but particularly in high-growth markets. And once again, this aids the penetration of these kind of therapeutics in the market.
And then lastly, I call it the turbocharger of the bioprocessing industry. It’s this transition to single-use technologies where you’re really going from bioprocessing 1.0 in the stainless steel type of setups, which can be cost-effective for very large drugs and large manufacturing campaigns but have high capital and operating costs.
So the single-use technologies where you have lower upfront investment, you have greater flexibility, especially for the myriad of new therapeutics that come out that don’t require necessarily the highest volumes. And so we have the largest single-use technology business in the marketplace, well over $1 billion business for us, and that is growing leaps and bounds well over 20%.
And so when you put all this together and you think about all the capacity increases that we have done here in the market and announced, you’ve heard us talk about Beijing, you’ve heard us talk about Cardiff, you heard us talk about Duncan and in South Carolina and many more, these are capacity utilization increases which are absolutely necessary here in the short term, but in view of the growth that I just talked about, will also be necessary to sustain the growth for the next 3 to 5 years is the way to think about it.
Derik De Bruin
Got it. Let’s bounce around. Let’s go to — let’s move to Diagnostics. So this — so can we talk this in terms of the core Beckman Coulter business and sort of what you saw in China and let’s move on. Let’s start there. And then I want to sort of like dissect Cepheid.
Rainer Blair
Sure. So let’s start with Beckman Coulter Diagnostics, which has continued to accelerate its growth here and is really on pace to be in that mid-single-digit area. In the last week of the first quarter, we did see China starting to slow down with patient volumes there as the hospitals locked up and focused on COVID. And of course, we saw that continue here in April, albeit we’re starting to see some loosening of those restrictions even in Shanghai here in April.
And as we’ve indicated, we think that for the total company here, we see in China about 200 to 300 basis points of headwind for the quarter as the lockdowns unwind within the second quarter, but that we can recover that in the second half of the year and maintain our guide. So that’s for sure the case. And I would say that’s what’s occurring at Beckman Diagnostics and the microcosm as well.
Derik De Bruin
So then on Cepheid, once again, I hate to hit on the negative, but we get a lot of people worried that, oh, my gosh, they’re not going to do $2 billion in diagnostics this year. I was like, “Well, no, and they — so we have told you that COVID is not going to be that number.” So it’s like how do we think about Cepheid. I mean you’ve doubled your installed base, You’ve got the biggest test menu. Its point of care clearly has this. So how do we sort of think about that and sort of like the COVID coming off and the growth in the business and expansion of the core business?
Rainer Blair
Sure. So let’s level set, first of all, on the installed base. And during the course of the pandemic here, we’ve more than doubled our installed base to over 40,000 instruments around the world. And we’ve been very careful with how we’ve placed those instruments in the sense that we’ve always tried to look beyond COVID testing and that those instruments would ultimately find application with our broader test menu.
And you may be aware, we have, in the U.S., over 20 tests approved by the FDA. And outside of the U.S., well over 30, and that’s by far the largest test menu at the point of care for molecular diagnostics. So we have a very, very strong value proposition there.
Now as you think about those placements here over the last 2 years, 65% of those placements went to existing customers and 35% of those went to new customers. But in all cases, we’re talking about the point of care where ultimately a physician is trying to make a therapeutic decision, making a call, as opposed to being in venues such as universities or sports venues or that sort of thing, we’ve maintained that in there.
Now of course, as COVID wanes and becomes endemic, and it’s a bit speculative to think about how that is, but we’ve triangulated and said we did 70 million tests here in 2021, 50 million tests is what we see for Cepheid around COVID for 2022. And then we’ve even talked about 30 million tests for 2023. So that’s how we see us moving from pandemic to endemic.
Now at the same time, we have the nonrespiratory non-COVID business, that’s a business that’s nicely over $1 billion, and we see that growing today at low double digits. As COVID testing starts to free up some of that installed base for those customers to be able to do other tests, we’re starting to see that happen here in the second quarter. So as testing for COVID starts to wane, we’re starting to see — early days, but we’re starting to see customers adopt other menu items.
Derik De Bruin
And you would think, I mean, we covered Cepheid well before you’ve acquired it. And so there’s always a lot of hospital labs that were interested in the technology but never got over the hump because, obviously, there’s a return on looking at particularly hospital-acquired infections, stuff like that. One would think now that these — now that you have systems in place, that those are sort of the tests that are going to be clearly uptake because there was a barrier for people buying. So as you — so I would expect that’s probably what we’re going to see one of the biggest pick-up is in the HAI business?
Rainer Blair
Absolutely. So well said, really, what we noted is people are really looking for an anchor assay to make that initial investment. And that’s — in the first phase before COVID, that anchor assay for us was really flu. And then as COVID progressed, everybody had an opportunity now to test for COVID whilst, at the same time, being able to take care of, as you suggest, hospital-acquired infections. We have sexually transmitted diseases and a myriad other tests and now can leverage that.
And it goes beyond that because COVID, of course, will not go away, right? You will still have that anchor assay and you will then be able to ultimately leverage that expanded menu. So we feel very good about that. We’ve deployed the go-to-market resources, so the salespeople to drive that business and to ensure that the appropriate training is in place so that we can continue to see that kind of growth going forward.
Derik De Bruin
Well, with the 70 people in the room here, we hope that COVID goes away. [Indiscernible] but 2 maths in the room.
Mike Ryskin
On the expanded installed base for Cepheid, I mean, in the last couple of years, there’s been a lot of sort of debate on the longer-term evolution of the diagnostics industry between the reference lab and the point of care and, even in the last couple of years, increased prevalence of at-home testing modalities. So 35% of your recent [instrument] versus going to new customer, sort of what’s your sense for how those various modalities are going to evolve over time?
Rainer Blair
So first of all, I’d start off with that we view home testing as complementary to the point-of-care testing. And we think that it has raised the general responsiveness of the population to actually go and get diagnosed. Now as it relates to the point of care, we actually do think and see that much of the testing is starting to move, if you will, from reference labs or core labs, really, to the point of care where the doctors want to be able to make a decision — a therapeutic decision quickly.
And as you think about home testing, and let’s play out the COVID scenario that perhaps you’ve lived personally, you start with your perhaps at-home antigen test and, oh, no, it’s positive. And ultimately, you’re worried and you want to go to a hospital to pursue some treatment. They will test you again at the point of care with molecular diagnostics before they make a treatment decision to give you a monoclonal antibody or some sort of antiviral. So we see them really as complementary, and that really manifests in the reality that we see in the marketplace as well as our business.
Derik De Bruin
So Rainer, can we — I want to do one more sort of like top line question before we start hammering on margins and sort of like the outlook there. So your long-term model is mid-single-digit plus organic revenue growth. So what’s the plus on this, right? So — because I mean, you sort of look at the portfolio, it certainly is a hell of a lot stronger than it ever has been, and markets are great, right? I think — I mean I’ve never seen demand like this in the space. So how should we sort of think about the — is this an 8% — is this a 7% to 9% grower business longer term? How should we sort of think about that plus?
Rainer Blair
Sure. Sure. Well, the plus really comes from the repositioning that I started off with. If you think about Danaher previously, we were a low to mid-single-digit kind of grower. I mentioned earlier the spins of Fortive, Envista and that we brought on many other companies, which I won’t name again. And then even there, what we see is that Cytiva is growing faster than we had originally thought. We thought it was more like a 6% to 7% grower. Now we see it more firmly in the high single digits. And then, of course, molecular diagnostics used to be less than 5% of our business. Now it’s over 10%.
And so what we’re saying here, and we see this for the long term, we’re trying to avoid rebasing our business with a different year or that sort of thing. We’re just saying, look, this is a really robust portfolio. It is not a cyclical portfolio. It is well entrenched in attractive end markets. And we see the likelihood of being — growing faster than mid-single digits to be high.
Derik De Bruin
So then how should we think about margin expansion in that scenario? And then I often get asked a question that’s like, I don’t think you guys have bought a share since the financial crisis. From the last time I remember, it’s like, why don’t you do — with your — obviously, you’re very good acquiring companies, but is there may be an opportunity to maybe — particularly given where the stock is right now, to maybe be a little bit more aggressive on the share buyback front?
Rainer Blair
As a whole are — and you’re aware, Derik, that our bias for capital allocation has been towards M&A. And that continues to be the case. And as Mike and I were just saying, we see the current market environment as an opportunity for us, which we are watching very closely.
Now we — as it relates to share buybacks, we already have that facility. We already have that authorization. And are we more likely to do something like that when the stock’s at $240 than at $330? Sure. But really, our bias is towards M&A and our capital allocation.
Derik De Bruin
And how should we think about the margins? So if you’re doing mid-single-digit-plus on the top line, that’s 50 to 75 basis points of margin expansion annually. Is that how we should think about it? And how do we think about where the margin opportunity is longer term?
Rainer Blair
I think that our earnings expansion is really going to be driven by a mix of things. First of all, if you look at the repositioned company that has, on average, 800 basis points higher margins, our EBITDA percentage is right around 35% already. And you think about the margin expansion opportunities that we have within the portfolio, I think that combination is really what gives you the leverage there to continue to drive earnings. So it’s really the fact that we’re already a 35% EBITDA kind of company that’s growing mid-single-digit-plus. And we have margin expansion opportunities within the portfolio that really drives that EPS growth going forward.
Mike Ryskin
Got it. On the 1Q call, the incremental margins, sort of the incremental margins for the rest of the year came in a little bit versus prior, and I think a lot of that had to do — some had to do with FX, some had to do with freight. Is there an opportunity to bring them back higher up? And is that long-term view still intact as you process the decremental margins from COVID diagnostics moving down, things like that? Because… [Technical Difficulty]
Rainer Blair
Let me piece that apart a little bit here. So let’s start off with the fact that our view as to our margin performance here is 35% to 40% VCM fall-through. That’s our view. And frankly, that’s rerated from what used to be 30% to 35%. And if you look at our underlying business performance, you look at the organic business performance in the base business, you look at the acquisitions, that 35% to 40% holds, and that’s how we view it for the long term.
Now already this year, when we came out of the first quarter, we talked about the fact that we thought that VCM might be 30% to 35%, already flagging some of the FX changes that we saw. And as we continued through the quarter here in the first quarter, we saw FX have changes on the order of magnitude that we haven’t seen in a long time, and also across the board with the world’s currencies. And so we still think that FX is important, and that’s why we anticipated that 25%. And we talked about here for the full year, the 20% to 25%, once again, all related to FX as opposed to the underlying business.
Now let me talk about the Cepheid testing volumes and how do we need to think about margins in relation to that. We have to recognize, first of all, that we did not price our COVID testing at a premium to other tests. So when we started off in this pandemic, and I know it’s hard to remember because it feels like it was such a long time ago, but back in March of 2020, we went through a great deal of analysis.
And we made the business decision and I might also say the responsible decision to price the COVID test at the same level as the flu test so that we would not get into a position, for obvious reasons, of being in the crosshairs of why are you, in this time period, pricing this at a premium? But also because we did not want to be in a situation where, as the pandemic wanes, suddenly, there’s a great deal of price and margin pressure. So as it relates to the COVID testing, while the volumes will decline over time, as we’ve described, we don’t see that as having an additional margin — set of margin pressures because it’s really running at the fleet average.
Derik De Bruin
Great. Any questions from the audience? So look, I have to ask this question because it’s on investors’ minds. Are you worried at all about biotech in the funding environment?
Rainer Blair
So I don’t worry much about that funding environment. And let me again piece that apart a little bit. First of all, when you do the analysis of the biotech sector and you look at the balance sheet of the great majority of the players, the average cash with — given the average burn rates is between 12 and 18 months. Sure, there’s some at 6 months, and then there’s others at 18 or 24, but let’s just say the average is right around 18 months. And we think that that’s quite significant and that will continue these innovators to keep driving towards hopefully lifesaving or certainly life-improving therapeutics.
But I think when you step back for a second and you put biotech funding in relation to the bioprocess business, the most important thing to remember is that the bioprocess business is volume-driven. It is volume-driven. It’s not the number of projects. It’s the volume per project that makes a difference. And with that, that means that commercial drugs and drugs that are really in the Phase III volumes are the ones that drive this business. And the ones that are earlier stage, including those early-stage biotechs, have an impact but only at the margin. It is not a driver of the growth of the business.
Now having said that, we’re always very interested in seeing a dynamic and vibrant biotech sector because that’s where the next Genentech, Biogen, Amgen and so forth will come from. And it’s important that we as a society and as an industry have that cauldron of innovation. But from our perspective, this is not something that will have an impact here on the business in the short term.
Derik De Bruin
And we’re almost out of time, you know my standard closing question. What’s underappreciated or misunderstood about Danaher?
Rainer Blair
Look, as you know, I love to talk about the fact that we are a different company today. We grew — we’re about 50% larger today in revenue than we were in 2019 with a totally different mix. I’ve talked about the repositioning of the portfolio in terms of the end markets, in terms of the growth rate, in terms of the margin, in terms of the degree of recurring revenue, think about going from 45% recurring revenue in 2015 to now 75%. So if you think then about the investments that we’ve made in innovation and in capacity increases, we feel really well positioned here for what’s happening in the short term, what’s happening in ’23 and certainly what’s happening beyond that in ’24 and beyond.
Derik De Bruin
And with that, thank you. Thanks for being here.
Rainer Blair
Thank you all.
Derik De Bruin
Thank you all for listening. Stay safe. Have a good conference.
Source: seekingalpha.com
